The Best Of All Possible Worlds

“Candide, the classic novel of the great French writer Voltaire, is a satirical description of a young man who has been taught that ‘everything is for the best in the best of all possible worlds’,” wrote Paul Hodges in this blog post last week.

Thus, we have been told while the world looks gloomy right now, China’s average polyethylene (PE) growth rate from 2008 until 2012 has been excellent.

And we keep being reassure that China will return to trend-growth next year and beyond, thanks to rising urbanisation and the growth in the country’s middle class.

Dr John Lee, Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University, wrote in this article:

“Much of the optimism is based on the decade-long orthodoxy – popular with executives and investment analysts hardwired into talking up the China story – that Chinese urbanisation has a long way to go. As China-bulls point out, half of the population is still classified as rural and will need modern housing and other infrastructure over time. According to the narrative, this effectively guarantees strong demand for commodities such as iron ore for the next couple of decades, while Beijing has several economic tools with which to arrest any immediate dramatic slowdown.

“All of this is true, but the analysis is still incorrect. Timing for dramatic changes in commodity prices is impossible to predict. But the reality is that China’s voracious consumption of commodities over the past decade has remarkably little to do with the genuine demands of urbanisation, makes little economic or commercial sense, and cannot continue.

“Since the mid-1990s, urbanisation has been advancing at the rate of less than 1.5 per cent each year. Yet fixed investment has been growing at 20 to 40 percent each year for the past decade. Fixed investment as a proportion of GDP increased from 38 percent in 1999 to 45 per ent in 2003 and over 50 percent currently.

“During the periods of rapid industrialisation in Japan, Taiwan and South Korea, fixed investment did not rise above 33 percent of GDP. That China is dangerously embarking on a unique and unprecedented economic path is further confirmed by the fact that formal bank loans increased from $750 billion in 2008 to $1.4 trillion in 2009. In the two years from 2008-2010, the amount of outstanding loans on the books of the country’s banks increased by 58 per cent.

“Obviously, and much to Australia’s delight, fixed investment needs steel, and steel making needs iron ore. Chinese steel production jumped from about 100 million tonnes in 2000 to over 400 million tonnes in 2005, to around 850 million tonnes currently. Analysts and forecasters need good data – which isn’t available in China – and rely on models based on key assumptions about economic rationality. The problem then is that these dramatic increases make no sense.

“Since governments cannot force their populations to consume, and Beijing has little direct control over consumption levels for its exports in advanced American and European Union economies, the only available policy response to a slowdown was to ramp up fixed investment levels – in short encouraging eager state-owned-enterprises to build things for the sake of it.

“In other words, Chinese levels of fixed investment, and levels of steel production specifically, over the past decade have been predominantly driven by politically-motivated stimulus policies rather than market-determined demand.

“The result of the unprecedented reliance on fixed investment to maintain jobs, stimulate economic growth in urban areas (which is vital for regime security) and as a way for ambitious provincial officials to exceed growth targets in a personal quest for political promotion are the increasingly well-documented ghost cities, tens of millions of uninhabited high-end apartments that are bought as speculative capital assets rather than as investments based on rental yield, and world class infrastructure projects that will be never be adequately utilised. Estimates by Chinese state-backed researchers suggest that still empty apartments built over the past four years could house over 200 million Chinese.”

Voltaire’s Candide found that the world was, after all, not the perfect place that he had imagined.